Europe's resilient economies

Little triggers

Recovery has been surprisingly strong but is now threatened by the euro crisis

THE euro area is under siege. Two of its members, Greece and Ireland, are in the IMF's intensive-care ward. The crisis threatens to engulf several others. Yet for all the bond-market turmoil, the real economy is doing well. GDP rose by 1.9% in the year to the third quarter (see chart). Business surveys point to annualised growth of at least 2% in the fourth quarter—slow by American standards, but not bad for an ageing continent.

It is also enough to eat into spare capacity, since output is growing faster than potential supply. The IMF, OECD and European Commission put euro-area potential growth at around 1%. Yet the jobless rate is broadly stable, at 10.1%, rather than falling as it should with growth above trend. This stickiness owes much to past labour hoarding: job losses did not match output falls during the recession, so many businesses have not needed to add to payrolls in the early stages of recovery. It may also be because European firms are making better use of information technology to boost productivity, as the Americans have, says Julian Callow of Barclays Capital.

Germany is the source of much of the region's zest. Its industrial output jumped by almost 3% in October alone. The business-confidence index published by Ifo, a Munich research institute, is at its highest since unification in 1990. Unemployment has fallen below the lows reached before recession struck. And a recovery that was at first based on exports of luxury cars and capital goods to fast-growing emerging markets is spreading to domestic demand.

Confident German firms are now investing and hiring more freely. Even cautious German householders are opening their wallets. So far, the rise in consumer spending has been lagging behind GDP growth. But as the jobs market tightens, pay is picking up, giving wage earners more spending power. The Bundesbank forecasts that consumption will grow at a similar rate to GDP by 2012.

Some other economies in Europe are also thriving. Most have either strong links to Germany or similar strengths. Sweden's export-dependent economy, like Germany's, was hard hit by the slump in world trade but has bounced back: GDP is up by 6.9% in the past year. The success of German-based firms in Asia's export markets has benefited suppliers in eastern Europe, notes Gillian Edgeworth, of UniCredit. The Czech Republic is one such: it sends around a third of its exports to Germany. Poland's resilience in the downturn and its current strength owe a lot to private spending at home and a big fiscal stimulus. There are mild nerves about a budget deficit that may hit 8% of GDP this year. But the bigger anxiety is about Hungary. Moody's, a rating agency, has cut its credit status to a notch above junk, worried that measures to tackle its budget deficit will not last.

Vigour at Europe's heart faces two big threats. The first is that fiscal tightening will begin in earnest next year. And the second is the trouble at Europe's fringes. Ireland and Greece are in deep recession. The austerity needed to stabilise their public finances will make it hard for them to climb out. Spain is barely growing and it too needs to tackle a budget deficit likely to be around 9% of GDP this year. Portugal's government has belatedly acted to cut a deficit of similar size. The delay has kept its economy afloat but has made bond investors more nervous.

These four countries account for less than a fifth of euro-zone output, so their frailty has not outweighed the strength in the rest of the region. They have, however, had an outsized effect on monetary policy because fears over some countries' solvency have made investors less willing to finance any of their banks (see article).

The European Central Bank (ECB) had hoped to make the terms of its liquidity support to banks less generous. But Jean-Claude Trichet, its boss, said on December 2nd that banks would continue to have access to ECB funds at its main interest rate, currently 1%, for up to three months. As Mr Trichet spoke, the ECB's traders were buying government bonds to prevent a run on some countries and to calm panicky markets. The ECB bought €2 billion ($2.6 billion) of such bonds in the week ending December 3rd, taking its cumulative purchases since May to €69 billion.

That the ECB has been pushed so far is because seemingly small financial tremors can quickly turn into earthquakes. This is a particular worry in the euro zone, where countries and banks alike are heavily exposed to one another's debts. Financial integration has been celebrated as one of the big successes of the euro. But it also means that more trouble in peripheral countries could easily spread to the entire euro-zone economy.